The Ecb Impasse

When the norms for external commercial borrowings (ECB) were relaxed in July 1997, Indian companies started scrambling to borrow cheaply abroad and jettison relatively costly Indian debt. A year and a half later, the crisis in south east Asia has clearly left its mark.

During the first nine months of fiscal 1998 although overall approvals were put at $ 8.5 billion, utilisation was dismal. Only $ 2 billion was brought into the country and another $ 2 billion reportedly retained abroad. According to one estimate, ECBs will see no more than half a billion dollars coming in for the rest of this fiscal.

 

The mega-rollback is already on the road. Recently, for instance, ABN Amro rolled back deals for Reliance Telecom and Reliance Power ($ 650 million). The Reliance group has been one of the largest overseas borrowers. It is no coincidence that as a spin-off of this, IDBI recently co-financed a Rs 400-crore rupee borrowing by the group.

No one in financial circles is surprised by this trend. With the forward premium shooting up, the effective cost differential between domestic term lending rate and ECB Libor and US treasury-linked rate have narrowed considerably," avers Kameshwar Rao, chief general manager, IDBI.

In fact, the reversal is already clear. Seven-year rupee funds currently cost 19 per cent compared with over 24 per cent for a seven-year dollar borrowing if you include a 15 per cent six month forward premium.

Appetite for Indian paper in international markets is also waning. This is partly a side-effect of the Asian crisis and partly the watch list status India has earned from Moodys. Then again the recession-induced squeeze on profits has had Indian companies shying away from international credit rating.

Explains S K Shelgikar, advisor to the board of directors, Videocon: It normally takes six to eight weeks for an issuer to actually hit the market after the ECB plans are approved. Therefore, all approvals given till the first week of September 1997 would have come to the market by the end of October. And this coincided with the Asian market turmoil. Faced with complete apathy for Asia, Indian deals could also not be closed."

The financial institutions, naturally, have been major beneficiaries of this reversal. This is reflected in the performance of the domestic financial institutions. Beginning the second half of fiscal 1998, they have seen a gradual reversal of the slowdown in credit offtake (see table: Term lending by the big four).

Is the decision to tap the ECB market guided solely by the international interest rate parity norm? If that is so, then the recent pre-emptive measures taken by the Reserve Bank of India (RBI) to avoid the contagion in the currency market by putting up the bank rate may well mark the beginning of widening interest rate differentials in the coming months. Which could mean renewed optimism for ECBs.

But Shelgikar vehemently disagrees with the argument. He believes that many borrowing decisions are irrational responses to the distorted and inefficient market system which is still controlled by the ministry of finance and the RBI. Why else would a company suggest raising ECB funds at 10.5 per cent at an effective cost -- after factoring in the cost of marketing and other formalities--- of 12-12.5 per cent? This is especially odd at a time when domestic rates are turning attractive," claims Shelgikar. Indeed, inclusive of the forward premium such borrowwings come close to domestic borrowings in terms of cost of fund.

Agrees Uday Mulgaonkar, associate vice president, Kotak Mahindra, People are overreacting to the immediate market instability. Mulgaonkar, in fact, suggests that ECBs could still be an attractive option. The floating libor rate, he explains, stands at 5.63 per cent. Add a spread of 250 basis point and the dollar loan would still cost 10.9 per cent less. So, as long as the rupee does not depreciate more than 11 per cent, ECBs would still be cost effective.

High forward margins should not be deterrents either. "Even if you go in for a six month forward contract at the present premium of 15 per cent, you are still left open for the remaining period of loan maturity. Assuming that the rupee will not depreciate by 11 per cent on a compounded basis, the cost of cover will come down on subsequent contracts," says Mulgaonkar.

N J Jhaveri, director, Kotak Mahindra Capital Company, attributes the market behaviour to the uncertainty linked with forex exposures of companies that do not have export earnings. "The present rush for rupee loans reflects the sudden run to guard against the uncovered forex risk as an impromptu reaction to the rising forward premiums. But this scenario is not likely to persist for long as it would not be possible for the domestic lenders to fund the future resource requirements. So the ECB market will see renewed activity once the forex market stabilises, he says.

How long will it take for the investment climate to improve is anybodys guess. The current trend is likely to continue in the short term. The rising domestic rates are closely trailed by the higher mark-ups over the libor rates. Analysts say the secondary market spread for Euro bonds over the base rates has crossed three per cent, and there is a complete disinterest for such issues.

Second, subdued export growth is likely to see this fiscal ending up with a current account deficit of $ 4.5 billion. This coupled with a lower net capital inflow, on the back of subdued FII portfolio investments and NRI deposit inflows, will mean a weakening rupee in the coming months. DD Rathi, group president, Indian Rayon, is sceptical about the stability of the rupee in the near future. The possibility of downward re-rating of the China and Hong Kong will keep the dollar market volatile. With six-month forward premium at 15-16 per cent, ECBs are clearly suicidal,

Lastly, the sustenance of the high interest rate strategy is questionable on account of excess liquidity in the Indian banking system.

The intensity of interest rate volatility that has occurred recently calls for inbuilt risk management mechanisms. Traditionally, term lending deals are done at a flat interest rate which means that borrowers are locked in with high cost of funds when interest rates are falling. A rollover at lower rates entails prepayment penalties that normally erodes the effective benefit of such restructurings. Things are however changing in the recent times.Following the last bank rate hike in December, ICICI has introduced multiple term lending rates with the reset feature. The borrowers can lock up term loans at a fixed rate for a year. The rate is then revised depending on the prevailing short term rate.

The lender still retains the prefixed margin. That makes it easier for the borrower to decide between external and domestic borrowings.